IRS Fiscal Transparency for Law Firms: CAAD Arbitration on Additional Tax Assessments 2009-2010

ARBITRAL DECISION

Carla Castelo Trindade, Arbitrator designated by the Deontological Council of the Center for Administrative Arbitration to form this arbitral tribunal, hereby issues the following

ARBITRAL DECISION

I – REPORT

On 26 June 2014, A, holder of tax identification number … and his wife, B, holder of tax identification number …, with tax domicile at … Estoril, falling under the Cascais Tax Service …, filed a request for arbitral determination, pursuant to the provisions of subparagraph b) of paragraph 2 of article 5º of the Legal Regime for Arbitration in Matters of Taxation (Decree-Law no. 10/2011, of 20 January), for assessment of the legality of the tax acts for assessment of Personal Income Tax ("IRS") relating to the years 2009 and 2010 with numbers, respectively, 2014 …, of 2014-02-15, with the amount payable of 2,090.14 €, which already includes 269.20 € of compensatory interest, and 2014 …, of 2014-02-15, with the amount payable of 49,897.27 €, which already includes 4,830.19 € of compensatory interest.

The aforementioned additional assessments of IRS resulted from the application by the Tax Administration of the fiscal transparency regime provided for in the Corporate Income Tax and Personal Income Tax Codes.

Not accepting the aforementioned tax assessments and compensatory interest, the Applicants requested the constitution of an arbitral tribunal, formulating the following requests:

i) Declaration of illegality and consequent annulment of the IRS assessments, no. 2014 … and no. 2014 … on the grounds of:

a) On unconstitutionality of article 20º, paragraph 1 of the IRS Code;

b) On expiry of the right to assessment regarding the year 2009;

c) On defects of violation of law;

d) On defects of deficient reasoning.

e) Declaration of nullity of the assessments of compensatory interest, in light of the annulment of the IRS assessments of which they are a consequential act; and

f) Condemnation of the Tax Administration to pay indemnificatory interest, pursuant to article 43º, paragraph 1, of the General Tax Law.

With the petition they submitted 13 documents, and further requested the statement of the husband Applicant A and listed the following witnesses:

i) C, … no. … • …;

ii) D, … no. … • ….

As the Applicants opted for non-designation of an arbitrator, pursuant to the provisions of subparagraph a) of paragraph 2 of article 6º and subparagraph b) of paragraph 1 of article 11º of the Legal Regime for Tax Arbitration, as amended by article 228º of Law no. 66-B/2012, of 31 December, the Deontological Council designated as arbitrator of the singular arbitral tribunal Dr. Carla Castelo Trindade who communicated acceptance of the charge within the applicable deadline.

The parties were notified of this designation, and no request for recusal of the designation of Dr. Carla Castelo Trindade as arbitrator was presented.

Thus, in accordance with the provisions of subparagraph c) of paragraph 1 of article 11º of the Legal Regime for Tax Arbitration, as amended by article 228º of Law no. 66-B/2012, of 31 December, the singular arbitral tribunal was constituted on 24 September 2014.

On 29 October 2014, the Tax and Customs Authority (hereinafter "Respondent") presented a response in which it defended the complete lack of merit of the request for arbitral determination and presented as witness Ms. Dr. E, Tax Inspector Level II, exercising functions in the Tax Inspection Services of the Finance Directorate of Lisbon, with professional domicile at …, Plot …, ….

By order of 18 November 2014, the tribunal notified the Applicants to, within 10 days, inform whether they maintained interest in the examination of the witnesses listed by them and, if the Applicants maintained interest in such examination, to indicate within 10 days which aspects of the initial petition would be the subject of such type of evidence.

In response presented by the Applicants on 28 November 2014, in which they expressed the intention to maintain the examination of witnesses, on 26 December 2014, the tribunal scheduled 28 January 2015, at 14:00, for the meeting under article 18º of the Legal Regime for Tax Arbitration.

At this meeting, presided over by Arbitrator Carla Castelo Trindade, there appeared Dr. …, representative of the Applicants, and Dr. … Legal Advisor in representation of the General Director of the Tax and Customs Authority.

The meeting could not proceed with the previously established agenda due to lack of understanding by the Applicants regarding its objective. Faced with this situation, the tribunal scheduled a new date for 6 February 2015, having set a deadline of 2 days for the parties to indicate which facts should be the subject of the examination of witnesses. The parties responded, with the Applicants indicating that they dispensed with the examination of witness D, resident in ….

However, following the impossibility of the esteemed Representatives of the Tax Administration attending the meeting under article 18º scheduled for 6 February 2015, a further new date was scheduled, this time for 25 February, at 10:30, for the holding of the meeting.

On 25 February 2015, at 10:30 as previously scheduled, the examination of the party took place, the witness listed by the Applicants – C – was heard and also the witness listed by the Respondent entity, Ms. Dr. E. All participants agreed to dispense with recording of the statements.

By suggestion of the tribunal and with agreement of the parties, written arguments were presented.

Both the Applicants and the Tax Administration presented arguments.

The Applicants concluded their arguments stating that they conclude as in the request for arbitral determination, and there should be complete granting of what was petitioned therein.

The Tax and Customs Authority counter-argued, reiterating the request for complete lack of merit of the present request for arbitral determination, as unproven, with the other legal consequences.

II. SANITATION

The arbitral tribunal was regularly constituted and is materially competent.

The case does not suffer from nullities and no questions were raised that might prevent knowledge of the merits of the case.

The parties have legal personality and capacity and are legitimate.

All considered, it remains to decide.

III. ON FACTS

III.1. FACTS ESTABLISHED

Regarding factual matters, it is first and foremost important to note that the tribunal does not have to pronounce upon everything alleged by the parties; rather, it has the duty to select the facts that matter for the decision and distinguish proven facts from unproven facts. All in accordance with article 123º, paragraph 2, of the Tax Code of Procedure and Process and article 607º, paragraphs 2, 3 and 4 of the Civil Procedure Code, applicable pursuant to article 29º, paragraph 1, subparagraphs a) and e), of the Legal Regime for Tax Arbitration. Thus, the facts relevant to the judgment of the case are chosen and selected based on their legal relevance, which is established in light of the various plausible solutions of the legal question(s) (see former article 511º, paragraph 1, of the Civil Procedure Code, corresponding to current article 596º, applicable pursuant to article 29º, paragraph 1, subparagraph e), of the Legal Regime for Tax Arbitration).

Now, considering the positions assumed by the parties, the documentary evidence, the Administrative Process attached to the court records, and also the examination of the party and the examination of the witnesses, the following facts are considered proven as having relevance for the decision:

1. The Applicants are passive tax subjects for IRS purposes, pursuant to article 1º, paragraph 1, and article 15º, in conjunction with articles 2º, 3º, 8º and 20º, all of the IRS Code, as amended by Decree-Law no. 198/2001, of 3/07 and subsequent amendments;

2. The husband Applicant derived in 2009 and 2010 income from category A (Dependent Employment), category B (Business Income and Special Imputation) and category F (Real Property Income);

3. For IRS purposes, the husband Applicant was until the date of 13/11/2009 classified under the simplified regime for determination of taxable income (articles 28º and 31º of the IRS Code), and for VAT purposes was registered under the normal regime with quarterly periodicity (article 29º and paragraph 1 of article 41º of the Value Added Tax Code - VAT Code);

4. The tax domicile of the Applicants is located at …, in Estoril, area of the Cascais Tax Service …;

5. The Applicants filed on 15/09/2010 and 06/11/2011 (outside the legal deadline, in accordance with article 60º of the IRS Code), the income declarations Form 3 of IRS, referring to the years 2009 and 2010, with Annexes A, B (without values), D, F and H, as defined in paragraph 1 of article 57º of the IRS Code, with references … and …, having, in light of article 13º of the IRS Code, declared two dependents with age over 3 years in 2009, and 1 dependent with age over 3 years in 2010, having also declared marital status of "Married";

Analysis within Society F, Law Firm, LLC

1. Within the scope of the analysis within Society F, Law Firm, LLC, from the analysis of Annex G of the annual declaration of accounting and tax information / AFS, submitted (pursuant to paragraph 1 of article 121º of the Corporate Income Tax Code) with reference to the fiscal year 2009, by Society F, Law Firm, LLC, NIPC … it was verified that the husband Applicant derived income from category B, subject to special imputation, since he is a partner of the aforementioned society, with a shareholding of 27.47% (year 2009) and 38.00% (year 2010)…

2. …having been imputed to him, respectively, the amount of € 318,146.80 and € 102,124.80, as determined by article 6º of the Corporate Income Tax Code;

3. It was likewise verified that the husband Applicant declared in Annex D of the income declarations Form 3, years 2009 and 2010, the amounts of € 318,146.80 and € 102,124.80, amounts that are in conformity with what was declared in the AFS submitted by Society F, Law Firm, LLC, relating to the same fiscal years;

4. In order to ascertain the amounts that by way of profits and/or advances on account of profits were paid or made available to the husband Applicant during the years 2009 and 2010, the tax inspection services requested from Society F, Law Firm, LLC, copies of analytical trial balances and extracts of account 26 (Partners), relating to the years in question;

5. It was in this context that, on 23 May 2012, Society F, Law Firm, LLC, was notified by the Tax Administration, through Office no. …, addressed to its Official Accounting Technician (OAT), to, in accordance with the principle of cooperation, provide copies of the following elements of the year 2009:

a. Extracts of current accounts 622 (Specialized Services), and

b. Extracts of current accounts 25 (Shareholders and Partners) (see DOC. 4, attached to the request for arbitral determination).

1. Within the scope of this preliminary analysis, the requested information was sent to the Tax Administration by email on 8 June 2012, and additional information was subsequently requested by email on 11 February 2013 (see DOC. 5, attached to the request for arbitral determination) and of 10 April (see DOC. 6, attached to the request for arbitral determination) addressed to the OAT of the society.

2. On 18 April 2013 and subsequently on 23 May 2013 the partner of Society F, Law Firm, LLC, Dr. A, traveled to the Finance Directorate of Lisbon to provide clarifications and deliver documentation (as evidenced by the examination of the party of the Applicant and the examination of the witness of the Applicant).

External Analysis of F, Law Firm, LLC

1. External dispatches nos. DI… and DI…, were opened in the name of the entity for the fiscal years 2005, 2006, 2007, 2008 and 2009, for purposes of consultation and collection of elements, to validate the regularization effected in the account of the aforementioned partner;

2. That is, on 16 July 2013, an inspection procedure was initiated at Society F, Law Firm, LLC, covered by dispatches DI… (DOC. 7 attached to the request for arbitral determination) and DI… (DOC. 8 attached to the request for arbitral determination).

3. After consultation, collection and cross-referencing of data, the Applicant was notified, by registered mail, of the notice of initiation of "external" inspection procedure by Office no. … of 2 August 2013 (DOC. 9 attached to the request for arbitral determination).

4. The inspection procedure denominated "external" had its commencement with the signature of Service Order no. …, dated 9 August 2013, (DOC. 10 attached to the request for arbitral determination) and termination with date 13 January 2014, with the signature of the diligence note (DOC. 11 attached to the request for arbitral determination).

External Inspective Analysis of the Applicant (year 2009)

1. No inspective acts were performed at the tax domicile of the Applicants, beyond the sending of notice letter and signing of the Service Order.

2. However, contacts with the Tax Administration occurred, at the instigation of those, through the OAT of the Society (in the capacity of third party), which in turn chose to provide the necessary information and documentation via correspondence.

3. The following acts were performed within the inspective procedure and which follow from the following chronology of facts:

· Sending of notice letter on 2 August 2013;

· On 8 August 2013, having verified the absence of the passive tax subject at his address, the passive tax subject was contacted by telephone, with a view to confirming receipt of the notice letter and scheduling the commencement of the inspective procedure;

· On that same date the passive tax subject came, via email (copy of email attached to the court records), to confirm that he would be absent, designating as his representative for those purposes and for intermediation in responses, Dr. C;

· During the inspective procedure personal contacts were made with Dr. C;

· During this process various elements were sent for justification of expenses, personal documents provided by the passive tax subject/his representative - such as calendars, various notes, email records sent from his mailbox -, which as suggested by the subject himself were made available by the Applicant under the full availability he always demonstrated before the Tax Administration;

· It proved to be, particularly within the scope of the examination of the party and the examination of witnesses, that these are not accounting elements and cannot be confused with the information collected in the scope of preliminary analysis in the society;

· It is proven documentally and by testimony that all elements, documents and clarifications requested were always provided to the Tax Administration.

1. On 19 December 2013, the Applicant traveled to the Finance Directorate of Lisbon to provide clarifications on a voluntary basis.

2. The service order closing the inspection denominated "external," ND …, was likewise signed in person, on 14 January 2014, at the premises of the Finance Directorate of Lisbon by the Legal Representative of the Applicant, Dr. C, designated pursuant to article 52º of the Complementary Regime of Tax Inspection Procedure.

3. On that same day, on 14 January 2014, the Representative of the Applicant received the Project Report.

4. On 29 January 2014, the Representative of the Applicant traveled to the Finance Directorate of Lisbon to deliver in hand the petition containing the exercise of the Right of Hearing from which, as will be seen below, resulted alterations to the projected.

5. On 12 February 2014, the Final Inspection Report was received (see DOC. 3 attached to the request for arbitral determination).

6. It follows from that final Report, in summary, that:

Conclusions of the Inspective Action

1. In the analysis performed on the amounts accounted for as reimbursements to the husband Applicant of expenses incurred in the name and on behalf of the Society, the Tax Administration distinguished the following:

a. Regarding properly documented expenses, the Tax Administration corrected those that were not invoiced in the name of the society;

b. Regarding undocumented expenses, even though subject to some justification, however insufficient, these were considered as incurred for the benefit of the husband Applicant due to the lack of an appearance of causality with the activity of the Society.

1. Thus, after analyzing the expenses indicated below, especially their supporting documents, the Tax Administration concludes that these were intended for use by the husband Applicant and his family members, in the terms transcribed from the Final Report, pages 12:

"in particular terms it is highlighted that, regarding expenses with fuel: − There are documents relating to expenses related to fuel, issued in the name of passive tax subject B, B, who is neither a partner nor a collaborator of the company, as well as in the name of G, son of the passive tax subjects here under analysis (see pages 15, 16, 21, 22, 23, 24, 29, 33, 24, 26, 37, 41, 42, 43, 46, 47, of Annex V);

to expenses with food: Documents were collected relating to expenses related to food, which are not issued in the name of the company, and do not contain, nor the identification of the associated trip, nor the persons present at the meals (see, for example, pages 30, 31, 38, 39, 40, of Annex V); − There are expenses that, by the type of meal (at the "…", at the "…", "…", "…", etc…), seem unlikely to be a contact with clients (see, for example, pages 30, 31, 38, 39, 40, of Annex V);

to travel expenses: − Some documents relating to expenses related to travel are issued in the name of passive tax subject A, A and his family, and do not contain the identification of the associated trip, suggesting that these are leisure trips and not business trips (see, for example, pages 6, 7, 20, 32, 35, of Annex V);

to hunting expenses: − In accordance with information given by the passive tax subject, the organization of these hunts "are necessary expenses for client acquisition". However, pursuant to the provisions of subparagraph h) of article 85º of the Statute of the Bar Association (Law no. 15/2005, of 26/1), "(…) constitute duties of the lawyer towards the community: (…) f) not to solicit clients, by himself nor by an intermediary" (see for example, pages 5, 8, 10, 12, 13, 14, 25, 26, 27, 28, of Annex V). On this prohibition of client acquisition, provided ethically, the Opinion of the Superior Council in Case R/36/98 of 11/12/1998, determines: "(…) as it is forbidden to the lawyer to conduct advertising through advertisements and mass media, it is likewise forbidden to the lawyer to solicit clients, all in defense of his dignity. The lawyer (from the Latin ad-vocatus, the one who is called) should be sought by the client for his competence and probity and should not, in any case and by any means, insinuate himself or offer himself to clients. Loyalty and trust are the cornerstones of lawyer-client relations, and this trust and loyalty will only exist when the client chooses his lawyer of his own free will and initiative, not neglecting, as is obvious, advice from acquaintances or information obtained by any means about the competence of the chosen one. There will only be loyalty and trust of the client in the lawyer when the latter is freely chosen by him (…)."

1. Faced with the facts exposed above, the Tax Administration concluded that these expenses supported by the company were intended for personal use of the partner/passive tax subject as an individual, as well as of his family members, which would constitute in its understanding an increase in patrimony in the sphere thereof, configuring true income for purposes of taxation in IRS.

2. In the understanding of the Tax Administration set forth in the Final Report, there were still other expenses, also relating to the years 2005 to 2009, that were left unjustified due to the fact that no supporting documents were exhibited/sent that would allow their validation.

3. The amounts paid to the husband Applicant were thus considered by the Tax Administration as having been paid by way of advance on account of profits.

4. That is, the reimbursement of the aforementioned expenses was considered as constituting "compensations" attributed to the partner now Applicant.

5. Finally, and as explained on page 18 of the Final Report, for purposes of calculating the total income derived by the husband Applicant, in his capacity as a partner of the aforementioned Society, the payments received that exceed the income imputed in accordance with the rules of article 6º of the Corporate Income Tax Code were considered, and the expenses accepted fiscally as being incurred on behalf of the Society were disregarded.

6. Resulting, in this way, an excess of advances on account of profits to be taxed in 2009 in the amount of € 13,365.32 and in the amount of € 90,982.46 to be taxed in 2010.

7. Notified of the project report, for purposes of the provisions of article 60º of the General Tax Law, the Applicants exercised, as already mentioned above, their right to prior hearing.

8. After analysis of the arguments presented and the new "documents that had not been attached to the requests for clarification made previously," the Tax Administration considered that part of the expenses that had not previously been justified, relating to fuel, food and travel (see tables 12 to 16 of the Final Report), was now proven to have been incurred in the name and on behalf of the company.

9. The corrections were then reformulated.

10. Notwithstanding the above, it is still concluded in the Final Report that all expenses recorded in the accounting of F, Law Firm, LLC, were subject to incidence and payment of autonomous taxation.

11. All expenses reimbursed to the husband Applicant were considered costs of the society in the year in which the respective reimbursement occurred.

12. All expenses reimbursed to the Applicant interfered, as negative elements, in the determination of the taxable matter of the society in the fiscal years 2009 and 2010.

13. Finally, on 27 February 2014, the Applicants were notified of the IRS assessments relating to the years 2009 and 2010 (DOC. 1 and DOC. 2 attached to the request for arbitral determination).

14. The deadline for payment was 31 March 2014.

15. The tax assessments and interest were paid.

III.2. FACTS NOT ESTABLISHED

As stated, regarding factual matters taken as settled, the tribunal does not have to pronounce upon everything alleged by the parties; rather, it has the duty to select the facts that matter for the decision and distinguish proven facts from unproven facts (see article 123º, paragraph 2, of the Tax Code of Procedure and Process applicable pursuant to article 29º, paragraph 1, subparagraphs a) and e), of the Legal Regime for Tax Arbitration).

Thus, the facts relevant to the judgment of the case were chosen and selected based on their legal relevance, which is established in light of the various plausible solutions of the legal question(s) (see former article 511º, paragraph 1, of the CPC, corresponding to current article 596º, applicable pursuant to article 29º, paragraph 1, subparagraph e), of the Legal Regime for Tax Arbitration).

Thus, considering the positions assumed by the parties, the documentary evidence the administrative process attached to the court records, and also the examination of the party and the examination of the witnesses, the facts listed above were considered established, as having relevance for the decision, and were not otherwise contested by the parties.

As for the fact not established, it is essentially due to the insufficiency of the evidence presented in its regard. In fact, the documents attached to the court records, and likewise the examination of the party and the examination of the witnesses are not, in themselves, susceptible to establish, beyond any reasonable doubt, the proof of the fact that follows:

1. The members of the tax inspection team were ever prevented from accessing the residence of the Applicants.

IV. ON MATTERS OF LAW

Preliminary Question on Jurisdiction

Considering the positions of the parties assumed in the documents presented, the central question to be resolved by the present arbitral tribunal consists in assessing the legality of the acts of assessment of IRS and respective compensatory interest.

As the Applicants imputed various defects to the impugned tax acts, the order of knowledge of the same must be determined, and the order of article 124º of the TCPC must be observed, applicable by force of article 29º, no. 1, subparagraph a) of the Legal Regime for Tax Arbitration[1].

The merits of any of the defects invoked by the Applicants will lead to annulment of the tax act. The arguments presented as defense by exception, that of unconstitutionality and that of expiry, will be analyzed first. Next, the arguments presented as defense by impugn will be examined. In this regard, the defect of violation of law is that which will lead to "the most stable or effective protection of the injured interests" insofar as its eventual merit will prevent renewal of the act, which does not occur with the annulment resulting from the other defects.

In conformity, the tribunal will first assess the defect of violation of law.

The question that must be assessed, independent of the position of the parties and under the principle of inquisitorial examination, consists in determining whether the Tax Administration could directly review the legal situation of the Applicants in the sphere of IRS without, first, making the correction in the sphere of Corporate Income Tax in the sphere of Society F, Law Firm, LLC, since it was subject to the fiscal transparency regime.

Preliminary Question – Brief Framework

In very general terms, and for purposes of theoretical framework, the tribunal begins by noting that at the origin of the fiscal transparency regime there is always a society, legal entity, or equivalent entity, which, were it not for its subordination to the fiscal transparency regime, would be taxed in Corporate Income Tax.

The fiscal transparency regime is therefore alternative to the general regime of taxation of income of societies and equivalent entities, hence it is understood, also by this tribunal, as a special regime.

Thus, the legislator, for reasons that we will attempt to ascertain later, created, in certain and determined types of business/business realities/professional situations a regime composed, of compromise, between the calculation of taxable matter following the rules of Corporate Income Tax and the imputation of this result to the partners who will thus be taxed under IRS or Corporate Income Tax depending on the case. It also created, for reasons that we will also see, a regime of exception to this general rule of the special regime.

But the fiscal transparency regime is special also because having as confessed objectives fiscal neutrality, the elimination of double economic taxation of distributed profits and the fight against fraud and tax evasion, it consists of an exceptional regime of taxation of certain collective entities and their partners.

The collective personality of the entity is therefore disregarded for purposes of taxation of the income derived by them, being this imputed, often independent of any actual distribution we say, to its partners or members, to be taxed under IRS or Corporate Income Tax, depending on whether these are individuals or legal entities[2],[3].

The controversial matter is then related to – also thus denominated/qualified by the Applicants –, the special regime of income taxation denominated fiscal transparency regime, provided for in current article 6º of the Corporate Income Tax Code (former and originally, article 5º). which, in the part that is relevant here states:

Article 6º

Fiscal Transparency

1 - The taxable matter, determined in accordance with this Code, of the following societies is imputed to the partners, integrating, in accordance with the terms of the applicable legislation, their taxable income for purposes of Corporate Income Tax or Personal Income Tax, as the case may be, even where there has been no distribution of profits:

a) Civil societies not constituted in commercial form;

b) Professional societies;

c) Societies of simple administration of property, whose capital stock is owned, directly or indirectly, for more than 183 days of the fiscal year, by a family group, or whose capital stock is owned, on any day of the fiscal year, by a number of partners not exceeding five and none of whom is a public legal entity

Thus, there is no doubt that this article establishes that the taxable matter is imputed to the partners of professional societies, integrating, in accordance with the terms of the applicable legislation, their taxable income for purposes of Corporate Income Tax or Personal Income Tax, as the case may be.

In this regard, article 15º provides, regarding entities subject to Corporate Income Tax which exercise, as a principal activity, a commercial, industrial or agricultural activity as is the case, what is considered taxable matter:

Article 15º

Definition of Taxable Matter

1 - For purposes of this Code:

a) Regarding legal entities and entities referred to in subparagraph a) of paragraph 1 of article 3º, taxable matter is obtained by deduction from taxable profit, determined in accordance with articles 17º and following, of the amounts corresponding to:

1. Fiscal losses, in accordance with article 52º;

2. Tax benefits if any consisting of deductions from that profit;

27º.

From this it follows that there is no specific, so-called special, rule for the definition of taxable matter in the fiscal transparency regime; it therefore follows the general rule provided for in article 15º of the Corporate Income Tax Code.

Also important to the analysis of the question at hand is what is provided for in article 20º of the IRS Code.

Indeed, this is the article that will tell us how to qualify in the sphere of the partners – when individuals – the product of the result that will be applicable to them after the calculation of taxable matter in accordance with article 15º of the Corporate Income Tax Code, but from 2009 onwards will tell us something more.

In truth, article 20º of the IRS Code underwent in 2009 a modification which, as we will see, is not of little consequence to the decision on the merits of the present action.

This provision stated in the version prior to Law no. 64-B/2008, of 31 December:

Article 20º

Special Imputation

1 - The income resulting from the imputation effected in the terms and conditions thereof constitutes income of the partners or members of the entities referred to in article 6º of the Corporate Income Tax Code, which are individuals.

2 - For purposes of the above paragraph, the respective amounts integrate as net income in category B.

The fundamental modification occurred with the wording given to the provision by Law no. 64-B/2008, of 31 December, through which the article came to provide that:

Article 20º

Special Imputation

1 - The income resulting from the imputation effected in the terms and conditions thereof, or, when greater, the amounts which, by way of advance on account of profits, have been paid or placed at the disposal during the year in question, constitutes income of the partners or members of the entities referred to in article 6º of the Corporate Income Tax Code, which are individuals.

2 - For purposes of the above paragraph, the respective amounts integrate as net income in category B.

3 - ....

4 - …

5 - In the event that the final part of paragraph 1 applies, the result of the imputation effected in subsequent years must be subject to the necessary adjustments intended to eliminate any duplication of taxation of income that may occur.

The objective of the legislator with this modification appears to us relatively straightforward.

Because there were several cases in which the so-called transparent societies did not distribute profits to the partners, making only advances on account of profits, thereby avoiding taxation in the sphere of the partner and erosion of the tax base in the sphere of the society, an anti-abuse rule was created.

Thus, from 2009 onwards, the taxation of transparent societies, and consequently of their partners when individuals, came to be effected in the following manner:

a) The taxable matter is calculated in accordance with article 15º of the Corporate Income Tax Code;

b) Its result is imputed to the partners in the proportion of their participation in the society;

c) Except if the amount to be imputed is less than the amount that has been paid or placed at the disposal of the partners during the year by way of advance on account of profits…

d) In which case it is this amount that is considered for purposes of taxation of the partner.

We therefore have a brake clause, a clause that says that the general rule of the special regime – that of taxation of the result of the imputation of taxable matter calculated for purposes of Corporate Income Tax – is set aside when its value is less than what results if the value of the amounts that have been advanced on account of profits is considered.

Thus, what the Tax Administration did in the case before the court was to consider that the expenses paid to the husband Applicant, and not accepted in the sphere of the society, are in truth advances on account of profits and therefore taxation under IRS should focus on this result and not on the result of the imputation to the partner of the taxable matter.

It would be correct, and therefore these acts of assessment of tax and interest should be maintained, should the expenses not accepted in the sphere of Society F, Law Firm, LLC, be susceptible of being qualified as advance on account of profits in the sphere of the Applicant partner.

It would not be correct, and therefore the additional assessments and interest should be annulled, deferring thus the petition in its entirety, should the non-qualification of the expenses not accepted as advance on account of profits be illegal. For in this case, even one might reach an equivalent result, but for that it would be necessary to resort to the general rule, that is, it would be necessary first to correct the taxable matter of Society F, Law Firm, LLC, disregarding in its sphere the cost that was accepted relating to the expenses that after all should not have been accepted, and lastly go correct the imputation effected to all partners reflecting thus the increase of the tax base – taxable matter – resulting from the correction effected. Along with this correction would have to be effected another one, this time, of reimbursement to the society of the value of the autonomous taxation that would have been paid regarding the expenses whose expense was not accepted.

Before, however, pronouncing ourselves on this concrete question – that of the defect of violation of law – it is necessary to analyze which arguments, and counter-arguments, were presented by the parties regarding the defense by exception.

Defense by Exception

A) Of the Invoked Unconstitutionality

The Applicants contend that paragraph 1 of article 20º of the IRS Code is unconstitutional due to violation of the principles of tax legality and tax equality, in the wording given to it by Law no. 64-A/2008, of 31 December, with reference to its final segment, which provides: or, when greater, the amounts which, by way of advance on account of profits, have been paid or placed at the disposal during the year in question.

In summary, the Applicants contend that the final segment of paragraph 1 of article 20º of the IRS Code, in the wording given to it by Law no. 64-A/2008, of 31 December, should not be applied due to unconstitutionality insofar as it violates the constitutional principle of tax legality, in its aspect of reservation of law in matters of incidence and of guarantees of taxpayers.

The Applicants further contend in this regard that the same provision ostensibly violates the constitutional principle of tax equality, emerging from article 13º of the Constitution, because, admitting without conceding that it does not violate the principle of tax legality, it only applies to partners of societies subject to the internal fiscal transparency regime who are individuals and does not apply to partners of societies subject to the internal fiscal transparency regime who are legal entities.

In equal circumstances, the partner of the same society, who is an individual, may, always to his detriment in light of the formulation of the final segment of paragraph 1 of article 20º of the IRS Code, see the taxable matter determined in the society subject to the internal fiscal transparency regime through presumed "advances on account of profits."

The Applicants thus contend that the final segment of paragraph 1 of article 20º of the IRS Code, in the wording given to it by Law no. 64-A/2008, of 31 December, violates the constitutional principle of tax equality, in the aspect of equality before the law and in its dimension of the prohibition of arbitrariness, and therefore should not be applied due to unconstitutionality.

Regarding this matter, the Tax Administration defended itself in its response by arguing that from the principles of contributive capacity and real income emerges the legal requirement to tax the available income in the sphere of the partner even when that income exceeds the taxable matter of the Society determined in accordance with the Corporate Income Tax Code, naturally with the adjustments to be effected in the subsequent year(s), in accordance with paragraph 5 of article 20º of the Corporate Income Tax Code. There does not exist, in the understanding of the Tax Administration, and in the understanding of the tribunal, any legal fiction embodied in paragraph 1 of article 20º of the IRS Code, since both in the situation in which profits are not distributed (paragraph 1 of article 6º of the Corporate Income Tax Code at the end) and in the situation in which profits are advanced paid (paragraph 1 of article 20º of the IRS Code at the end), the income to be taxed is already revealed through a contributive capacity that, in the first case manifests itself through the taxable matter determined in Corporate Income Tax in the sphere of the Society, even though the corresponding profit has not been distributed among the partners, and in the second case is revealed by the anticipation in the sphere of the partner of an availability to be imputed to the taxable matter of the Society to be determined in the subsequent year(s), but already distributed to the partner on account of that year. The Tax Administration is thus correct, and therefore also correctly stated when it refers that both the legislator of IRS and that of Corporate Income Tax are the same – in the limit the members of Parliament…

Finally, we believe the Tax Administration was also correct in referring that the thesis defended by the Applicants does not hold when they defend that recourse was made to indicia, presumptions or other elements that the tax authority had at its disposal, in accordance with the criteria listed in article 87º of the General Tax Law and consequently any legal requirement regarding the verification of the respective assumptions and specific procedural rules since the indirect methods of taxation aim, as provided in article 83º, paragraph 2 of the General Tax Law, "at the determination of the value of taxable income or property starting from indicia, presumptions or other elements that the tax administration has."

In summary, the tribunal considers that the argument of unconstitutionality alleged by the Applicants does not proceed when they contend that article 20º, paragraph 1, of the IRS Code, in the wording introduced by Law no. 64-A/2008, of 31/12, is affected by unconstitutionality.

B) Expiry

The Applicants also invoke that the contested assessment relating to IRS of 2009 was notified to them after the expiry deadline provided for in article 45º of the General Tax Law had ended. This because they consider that as the tax inspection underlying it does not have the nature of external, it would not have suspended the expiry deadline for assessment in accordance with what is provided in paragraph 1 of article 46º of the General Tax Law.

The classification of the inspective procedure as internal or external determines the application of specific procedural rules and a specific legal regime regarding, for example, the possibility of conducting another inspective action with the same passive tax subject, year and tax (article 63º, paragraph 4 of the General Tax Law) as well as the suspension of the expiry deadline of the right to assessment.

It was this question of qualification of the inspection as internal or external that caused the tribunal to insist on the holding of the meeting referred to in article 18º despite the successive difficulties.

It is unanimous in doctrine and jurisprudence that the qualification of an inspection as internal or external does not depend on the parties, particularly the Tax Administration. What matters to the qualification of an inspection as internal or external are the inspective acts actually performed during the course of the inspective action. Substance prevails over form.

In this sense, arbitral decisions have already been issued in proceedings of the Center for Administrative Arbitration, particularly in cases 8-2012T and 14-2012T, having, in the first of those, been written:

"Just as expressly results from the normative provision of article 46º of the TCPC, only the external inspection procedure possesses the virtue of suspending the counting of the expiry deadline.

And it is understood that it should be so. Indeed, pursuant to paragraph 1 of article 2º of the Complementary Regime of Tax Inspection Procedure (RCPIT), "the inspection procedure aims at the observation of tax realities and the prevention of tax infractions," being the procedure classifiable as internal, in accordance with article 13º of the same statute, whenever the acts of inspection take place exclusively in the services of the tax administration "through formal analysis and coherence of documents," and external, "when the acts of inspection are performed total or partially, in installations or dependencies of passive tax subjects."

Further on:

"as it appears evident in light of the most elementary principles of legal hermeneutics, it is not the simple fact of designating the procedure as external, without any material acts of inspection being performed after the signing of the service order, that confers upon it the aptitude to suspend the counting of the expiry deadline."

Already in the decision issued in case 14-2012T, it can be read:

"5 – The criterion for distinguishing between procedures of internal and external inspection is extracted from art. 13º of the Complementary Regime of Tax Inspection Procedure, in which it is clarified that the procedure is internal «when the acts of inspection are performed exclusively in the services of the tax administration through formal analysis and coherence of documents» and is external «when the acts of inspection are performed, total or partially, in installations or dependencies of passive tax subjects or other obligated taxpayers, of third parties with whom they maintain economic relations or in any other location to which the administration has access».

The criterion for distinguishing between procedures of internal and external inspection is thus based on the existence or not of acts performed outside the services of the tax administration for obtaining the relevant elements: if the acts were performed exclusively in those services, one is dealing with an internal procedure; if some or some acts necessary to ascertain the tax facts were performed outside those services, «total or partially», one is dealing with an external procedure."

Again in the same decision:

"The inspection will only be qualifiable as internal when it was performed based on documents not obtained through inspective acts exterior to the services."

Now, after all the testimonies and also considering the examination of the party, and taking into account the documents and the conclusions brought to the court records within the scope of the inspective process, the tribunal considers that also here the thesis of the Applicants lacks factual and legal support.

In the case at hand, it became clear that the Tax Administration chose to open an external inspection for the reasons explained by the witness questioned in the capacity of tax inspector, that is, in harmony with a methodology previously implemented by the Services with a view to analyzing the situations arising from the aforementioned amendment to article 20º of the IRS Code, as it was considered that mere internal analysis of coherence was not sufficient.

It was proven that prior to the opening of the external inspection procedure, and despite the quantity of documents it had already obtained under the principle of cooperation, the Tax Administration did not have in its possession the necessary elements for the inspective action, hence there would always be the necessity to perform external inspective acts with a view to obtaining them.

After all, the registration books that the Applicant is obliged to keep, in compliance with the obligation imposed by article 116º of the IRS Code, should be centralized at his tax domicile, as provided in article 118º of the same legal statute. Only for convenience and at the indication of the taxpayer were the elements sent to the Tax Administration by his OAT, which does not alter the external nature of the inspective action.

In this manner, it follows from the present court records that the acts of inspection performed by the Finance Directorate of Lisbon were not performed exclusively in the services of the tax administration through formal analysis and coherence of documents, with the performance of external inspective acts being proven. The elements that are analyzed within the scope of the inspective procedure are personal documents provided by the husband Applicant.

It is noted that the fact that there was no collection of documentation at the tax domicile of the passive tax subject was due solely to the fact that the husband Applicant indicated to the Tax Administration that contacts should be made through his OAT. In fact, although there was no direct contact with the passive tax subject at his tax domicile, the external diligences performed permitted ascertainment of important facts for the conclusions of the inspective procedure.

Terms in which the alleged expiry of the right to assessment of IRS of 2009 and consequent adjustment made under IRS of 2010 should be judged as without merit, due to the fact that the respective deadline was suspended pursuant to paragraph 1 of article 46º of the General Tax Law.

Defense by Impugn

C) Violation of the Rule of Precedence in Determination of Taxable Matter in Accordance with What is Provided in the Corporate Income Tax Code

The Applicants argue in this point that since the corrections made to the income by imputation to the husband Applicant relate to reimbursement of expenses not justified or non-accepted expenses, these should have been reflected, by their very nature, immediately on the society and not immediately on themselves.

In this argument the tribunal will dwell with greater acuity, because the resolution of the question at hand is in the answer to this matter.

The Applicants argue in this regard that what is not in question here is the eventual question of the autonomy between the societal patrimony and the personal patrimony that the costs that were object of those value judgments by the Inspection (unjustified expenses and non-accepted expenses) could raise. On the formal and accounting level, expenses and costs are at issue that are formally documented and have correct documentary proof, recorded in the accounting of the society and which, consequently, were integrated in the determination of the taxable matter of the corresponding fiscal years (at least 2009 and 2010) as their negative elements.

Their non-acceptance as fiscal cost, say the Applicants, naturally imposed the correction of the taxable matter of those fiscal years, and then what is denominated in article 90º of the IRS Code as "reformation of assessment," in the following terms:

"Whenever, regarding entities to which the regime defined in article 20º applies, there are corrections that determine alteration of the amounts imputed to the respective partners or members, the Directorate-General of Taxes proceeds to reformation of the assessment made to them, collecting or annulling in consequence the differences ascertained."

The Applicants argue in this regard that the husband Applicant was not the only partner of Society F, Law Firm, LLC, in the fiscal years 2009 and 2010, holding therein, in those same fiscal years, participations of, respectively, 27.47% and 38%. And that if the consideration of such expenses and charges was integrated as a negative element in the determination of the taxable matter of the society and was this that was imputed to the remaining partners, its non-correction, by disregarding it as a fiscal cost of such expenses and charges, and concomitant reformation of the assessment of the remaining partners, translates itself for them not only in a form of illicit enrichment that the legislator surely did not want but, above all, in a modulation of the individual tax obligation, absolutely contrary to law, if not even terminally prohibited. It is thus the law that fixes the order of precedence of action and it cannot be the applicator of the law to alter this order of precedence, under penalty of total illegality, say the Applicants.

The Applicant thus concludes that it was illegal the procedure of the Tax Inspection insofar as, having weighed that certain expenses and charges, properly documented and recorded in the accounting of the society subject to the internal fiscal transparency regime, did not meet the legal requirements to be qualified as fiscal costs, it did not proceed first to the correction of the taxable matter of the society, only afterwards proceeding to reformation of the assessments of the respective partners.

The Tax Administration in its Response refers to the answer given in the scope of the right of hearing, in which it concluded that:

"[...] the corrections made relate to reimbursements of expenses that are made by the society to partner A, and that being the passive tax subject the recipient of these expenses, these could never be imputed to the other partners through application of the rules of article 6º of the CORPORATE INCOME TAX CODE, as a matter of tax justice and equity. In truth, the reimbursement of these expenses represents an increase in the contributive capacity of the passive tax subject, whereby it does not make sense to repercuss this charge on the remaining partners of Society F - LAW FIRM, NIPC ….

It is thus concluded that it is the pretension of the passive tax subject that the expenses with food, fuel, travel and other entertainments supported by the law firm, but whose enjoyment/benefit was of the managing partner and his family group, be disregarded in the sphere of the society and the corrections imputed also to the remaining partners.

Now, in the name of tax equity, it appears evident that, where these are incomes of the passive tax subject, it is this one that should bear the burden of the missing tax and not repercuss it to third parties"(Pages 26-27 of the RIT).

It further asserts that "As is stated in the Final Report, "the reimbursement of expenses incurred in the name and on behalf of the society is provided for, both under Corporate Income Tax (for purposes of deduction of expenses in accordance with article 23º of the CORPORATE INCOME TAX CODE), and under VAT (for purposes of deduction of VAT supported, in accordance with the rules provided in articles 19º, 20º, 21º and 22º of the VAT CODE), to deal with situations in which, by the nature of the activity, the collaborator(s) of the company, or third parties incur various expenses in the exercise of their activity, in the name and on behalf of the society" (page 10 of the RIT)

Thus the Tax Administration argues that:

a) Since the aforementioned law firm, as it is a society of fiscal transparency, although a passive tax subject for Corporate Income Tax, is not taxed under the said tax, except as regards autonomous taxation, in accordance with article 12º of the Corporate Income Tax Code;

b) That, taxable matter being determined in accordance with the aforementioned Code, integrated in the taxable income of the partners - see paragraph 1 of article 6º of the Corporate Income Tax Code and article 20º of the IRS Code and providing in paragraph 3 of article 6º of the Corporate Income Tax Code, that the said imputation "(...) is made to the partners or members in the terms that result from the constitutive act of the entities mentioned therein or, in the absence of elements, in equal parts";

c) And that, regarding the imputation to the partners, article 20º of the IRS Code provides: "1 - The income resulting from the imputation effected in the terms and conditions thereof, or, when greater, the amounts which, by way of advance on account of profits, have been paid or placed at the disposal during the year in question, constitutes income of the partners or members of the entities referred to in article 6º of the Corporate Income Tax Code, which are individuals"

d) And further that, still pursuant to article 6º, no. 4 of the IRS Code, it is provided that: "4 - Entries in any current accounts of the partners, recorded in commercial or civil societies under commercial form, when they do not result from loans, from the performance of work or from the exercise of corporate positions, are presumed to be made by way of profits or advance on profits."

For purposes of IRS, advances on account of profits are taxed as income of Category E (Capital) when they originate from a society subject to Corporate Income Tax, whereas in the case of societies subject to the fiscal transparency regime, such income should integrate the net income of Category B, in accordance with paragraph 2 of article 20º of the IRS CODE: "2 - For purposes of what is stated in the preceding paragraph, the respective amounts integrate as net income in category B".

In summary, concludes the Tax Administration that having the Inspection Services concluded that, in accordance with the principles of tax justice and equity, the performance of a correction in the taxable matter of the society would lead to imputation to the remaining partners of compensations that would only benefit the husband Applicant, who was in truth the beneficiary of the expenses in question and taking into account that the Tax Administration does not intend to interfere in any "normal acts of management," whereby it did not oppose the society, in the exercise of its activity, to assume as an expense, personal expenses associated with the husband Applicant, however these cannot fail to be considered as compensations/remuneration of the partners, determining the tax rules cited in the Tax Inspection Report that such "retributions" are subject to IRS.

Faced with the arguments of the parties it remains thus to decide.

As we had the opportunity to state, with the wording given to article 20º of the IRS Code by Law no. 64-B/2008, of 31 December, the taxation of transparent societies, and consequently of their partners when individuals, came to be effected in the following manner:

a) The taxable matter is calculated in accordance with article 15º of the Corporate Income Tax Code;

b) Its result is imputed to the partners in the proportion of their participation in the society;

c) Except if the amount to be imputed is less than the amount that has been paid or placed at the disposal of the partners during the year by way of advance on account of profits…

d) In which case it is this amount that is considered for purposes of taxation of the partner.

We characterized as understandable the objective of the legislator with this modification. And why?

Because there were several cases in which the so-called transparent societies did not distribute profits to the partners, making only advances on account of profits. With this "scheme" one thus avoided taxation in the sphere of the partner through the fiscal transparency regime and erosion of the tax base in the sphere of the society.

Let it be understood in this regard that with this anticipation of profits there was created an erosion of the tax base of the so-called transparent societies because these amounts distributed as advances on account of profits, in the great majority of cases, neither accounting nor fiscally were/are taken as costs of the society and, consequently did not influence the taxable matter determined in accordance with the Corporate Income Tax Code. Indeed, in the determination of taxable matter the accounting profit (article 17º, paragraph 1, of the Corporate Income Tax Code) may be negative, there being therefore no results to distribute and that one to be positive, with taxable matter to impute. The opposite is also possible, that is, the accounting profit may be positive, there being therefore profits to distribute, and the taxable matter negative, with this not being imputed. It is exactly because there does not exist a permanent relationship of symmetry between profit calculated based on accounting and positive taxable matter determined according to the rules of the Corporate Income Tax Code and between loss calculated based on accounting and negative taxable matter determined according to the rules of the Corporate Income Tax Code that this anti-abuse rule was created.

We therefore have a brake clause, a clause that says that the general rule of the special regime – that of taxation of the result of the imputation of taxable matter calculated in accordance with the Corporate Income Tax Code – is set aside when its value is less than what results if the value of the amounts that have been advanced on account of profits is considered (those which accounting and fiscally did not influence the result of taxable matter).

Now, there is no doubt that what the Tax Administration wanted in the case at hand was to set aside the general rule – of imputation of the result of taxable matter calculated in accordance with the Corporate Income Tax Code – and apply the exceptional rule – of taxation of the amount advanced on account of profits. It remains then to know whether or not it had to first make a correction to taxable matter before correcting in the sphere of the Applicants.

We advance in this regard that the answer to this question depends on another. It depends on knowing what is to be understood as advance on account of profits in the sense of article 20º in fine of the IRS Code.

Here arrived at, one must know then what "advance on account of profits" refers to then the final part of paragraph 1 of article 20º of the IRS Code.

To those that are presumed in accordance with article 6º of the IRS Code?

Or to those effective, effected in the exact terms of what is provided in article 297º of the Commercial Companies Code? Those that neither accounting nor fiscally could be taken as costs of the society and, consequently never could influence the taxable matter determined in accordance with the Corporate Income Tax Code, and consequently the imputed taxable matter.

Or to both? To the effective of article 297º of the Commercial Companies Code and to the presumed of article 6º of the IRS Code?

If it is those presumed, then we are speaking of "entries in any current accounts of the partners, recorded in commercial or civil societies under commercial form, when they do not result from loans, from the performance of work or from the exercise of corporate positions," as is stated in paragraph 4 of article 6º of the IRS Code. If it is those presumed then we speak of entries that as a rule have underlying, as the Tax Inspection Report abundantly seeks to demonstrate, reimbursements of expenses that are/were considered burden/cost in the society and that negatively influenced the determination of its imputed taxable matter (the taxable matter was less than what it would be in the absence of such burdens).

But if it is those presumed and the Tax Inspection understands that they do not respect the principle of indispensability (article 23º of the Corporate Income Tax Code), it should then correct the taxable matter and afterwards tax in the sphere of the partner. This operation will occur whenever the Tax Administration considers there to be distribution of presumed profits and independent of the type of regime to which the society under inspection is subject:

a) If it be the general regime of Corporate Income Tax, it must correct the taxable matter of the society by disregarding the corresponding costs, and at the same time, add to the partner who obtained such reimbursements the presumed income by way of profits or advance on account of profits qualifying as income of Category E;

b) If it be the fiscal transparency regime, it must correct the taxable matter of the society by disregarding the corresponding costs, add to the partner who obtained such reimbursements the presumed income by way of advance on account of profits qualifying as income of Category B insofar as article 5º, paragraph 2, subparagraph h) of the IRS Code.

That is, if one understands that "advance on account of profits" to which then refers the final part of paragraph 1 of article 20º of the IRS Code is to be read in the terms of paragraph 4 of article 6º of the IRS Code then any change should give rise to the necessity to review, first of all, the taxable matter and only afterwards proceed to reformation of assessment. Which the Tax Administration did not do.

On the other hand, if it is those effective profits, i.e., those effected in the terms of article 297º of the Commercial Companies Code, then we are speaking of a reality quite complex but that, for what is relevant here, we can define as an anticipation of the profit of the fiscal year, agreeing with the thesis of the Applicants, that is, advances on account of profit that the society foresees to achieve in that year[4]. There would then be no necessity to review the taxable matter but the Tax Administration would have to have grounded its decision in another manner managing to prove that we are dealing with anticipation of the profit of the fiscal year in this perspective.

However this tribunal understands that in the final segment of article 20º both realities qualifiable as advance on account of profits fit, both the presumed advances on account of profits – those that are in article 6º no. 4 – and the effective advances on account of profits – those that are in article 297º of the Commercial Companies Code.

Here, despite the scant Doctrine on the matter, we do not believe we are alone.

It is stated in this regard by Professor Xavier de Basto that the so-called «fiscal transparency regime» provided for and regulated in article 6º of the Corporate Income Tax Code "disregards, for purposes of taxation under Corporate Income Tax, the collective personality regarding certain societies and other entities, imputing the respective profits, even if not distributed, to the partners or members, in the terms that result from the constitutive act or, in the absence of elements, in equal parts (cf. nos. 1 and 3 of the said article 6º).

This disregard of legal personality, or passive tax personality, leads to these entities subject to this regime not being taxed under Corporate Income Tax, as results from article 12º of the Corporate Income Tax Code, despite the respective income being determined in accordance with the rules of that tax. The income thus calculated, if the partners or members of those entities were individuals, will integrate itself in the global income of the partners, being considered, for the purposes of IRS, as income of category B"[5].

It should be noted that, as underlined by Professor Saldanha Sanches[6] although the aforementioned article 12º of the Corporate Income Tax Code is included in the chapter relating to exemptions from Corporate Income Tax, this is not here a matter of any tax benefit, but rather of a structuring element of our fiscal system, in accordance with the terms of which it is determined that the obligation of tax arises in the sphere of the partners, together with the other income that these have obtained individually, thereby avoiding that profit being taxed twice – first in the society under Corporate Income Tax and then upon being distributed, again, in the sphere of the partners – and these income not being considered as capital income, as indeed results expressly from the exclusion contained in the final part of subparagraph h) of paragraph 2 of article 5º of the IRS Code.

Already Rui Morais[7] states, in reference to the imputation rule contained in paragraph 3 of that article 5º of the Corporate Income Tax Code (combined with what is provided in article 19º of the IRS Code ― current article 20º) that "The obligation of imputation exists independent of any actual distribution".

In the work referenced above, Xavier de Basto highlights that this regime ensures, moreover, "when correctly applied, that the interposition of a society or other collective entity does not permit the partners or members to benefit from tax advantages," leading to a situation of neutrality with respect to the situation in which the activity is exercised directly in the individual sphere, particularly in cases where, as occurs in professional societies, which as is known constitute "the core of our fiscal transparency regime," in which "the personal element is determinant," inasmuch as "its success depends, above all, on the work and professional prestige of its partners," and "the capital element does not assume relevance to the market (at least in terms of clientele)"[8].

Conclusive is, however, the position defended by Dr. Manuel Faustino, in "The Opacity of Fiscal Transparency," CTOC Magazine, June 2009, pages 28 to 31. It is then proposed in this article that until the amendment of paragraph 1 of article 20º of the IRS Code the distribution of profits of societies subject to the fiscal transparency regime "was absolutely irrelevant on the fiscal level." This situation did, however, change with the aforementioned legislative amendment after which, notwithstanding "the core of the fiscal transparency regime [continuing] to be, under Corporate Income Tax, the imputation to the partners of the societies subject to it, «of the taxable matter determined in accordance with this Code," the legislator came to attribute relevance to the amounts paid or placed at the disposal of the partners by way of advance on account of profits, with the same author considering that "If, existing «effective advances» and «presumed advances» we have no doubt in affirming that, the legislator not having distinguished, and presuming, in accordance with the legal terms he consecrated the best solution, the sum of both should be considered".

We therefore have no doubt that the final segment of article 20º no. 1 of the IRS Code when it refers to advances on account of profits refers to the broader realities of article 297º of the Commercial Companies Code – to effective profits – and to the realities provided for in the presumption of paragraph 4 of article 6º - to presumed profits.

This qualification is nevertheless not of little consequence even if remotely it leads to the taxation of the partners of so-called transparent societies by advance on account of profits. It is not of little consequence because if they are those – the effective – the Tax Administration in the scope of additional or ex officio assessment will not have to proceed to any revision of taxable matter since they are realities that did not previously influence it. Already if they are these – the presumed – the Tax Administration in the scope of additional or ex officio assessment will have to proceed to revision of taxable matter since they are realities that previously influenced it.

Thus, notwithstanding this tribunal concludes that in the case of we being before an application of the special rule of taxation of article 20º in fine of the IRS Code there will be no necessity of correction to taxable matter when the advances on account of profits are those of the sense of article 297º of the Commercial Companies Code, the truth is that in the case at hand the Tax Administration always defended, both in its Report and in the documents in the present proceeding, that we are dealing with mere arithmetic corrections to taxable matter. This because it considered that the advances on account of profits at issue in the case before the court are those "entries in any current accounts of the partners, recorded in commercial or civil societies under commercial form, when they do not result from loans, from the performance of work or from the exercise of corporate positions," that is, those of paragraph 4 of article 6º of the IRS Code. To be such, there should always have been a proceeding to the correction of the taxable matter of the society by disregarding the corresponding costs.

In summary, it is thus concluded that the additional assessments of IRS and interest are illegal due to a defect of violation of law insofar as, the Tax Administration not having proceeded to any revision of the taxable matter of the society, such would only be legal in the case at hand if one were dealing with advance on account of profits in the sense scrutinized by article 297º of the Commercial Companies Code, which manifestly is not the case.

In consequence, it is concluded that the correction made has no legal foundation, and therefore is affected by a defect of violation of law due to error on the assumptions of law, which justifies its annulment in accordance with article 135º of the Code of Administrative Procedure, applicable in accordance with article 29º, paragraph 1, subparagraph d), of the Legal Regime for Tax Arbitration and paragraph 2, subparagraph c) of the General Tax Law.

The petition for arbitral determination thus entirely proceeds.

D) Of the Erroneous Qualification and Quantification of Income Imputed to the Partner

Just as has already been previously decided in the scope of arbitration in Case no. 91/2012-T – CAAD: "The full merit of defects of violation of law prejudices knowledge of formal and procedural defects, as follows from the order of knowledge of defects provided for in paragraph 2 of article 124º of the TCPC, subsidiarily applicable by force of what is provided in subparagraph a) of paragraph 1 of article 29º of the Legal Regime for Tax Arbitration".

In truth, the establishment of an order of knowledge of defects is only justified if the eventual merit of the priority knowledge defects makes unnecessary the knowledge of the remaining ones, for if it were always necessary to know all the defects the order of their knowledge would be irrelevant.

By the foregoing, as the defects of violation of law proceed, knowledge of the defect of erroneous qualification and quantification of income imputed to the partner is prejudiced.

E) Of the Absence or Defect of Legally Required Reasoning for the Corrections Made to Imputed Taxable Matter

Just as stated in point D above, as the defects of violation of law proceed, knowledge of the defect of absence or defect of legally required reasoning for the corrections made to imputed taxable matter is prejudiced.

F) Defects in the Assessment of Compensatory Interest

As the assessment of IRS is annulled, the assessment of compensatory interest comes to be affected superveniently with nullity, as follows from article 133º, paragraph 2, subparagraph i), of the Code of Administrative Procedure, applicable by force of what is provided in article 2º subparagraph c), of the General Tax Law.

G) Indemnificatory Interest

The Applicants further request that the payment of indemnificatory interest be determined, in accordance with article 43º, paragraph 1, of the General Tax Law, regarding the amounts of 269.20 € and 4,830.19 € referring to the years 2009 and 2010 respectively and whose payment deadline was 31 March 2014. Like the tax, the amounts due by way of compensatory interest were subsequently paid, as is seen from document no. 1 and 2 attached with the request for arbitral determination.

In harmony with the provisions of subparagraph b) of article 24º of the Legal Regime for Tax Arbitration, the arbitral decision on the merits of the petition to which no appeal or impugn lies is binding on the Tax Administration as from the end of the deadline provided for appeal or impugn, and must this, in the exact terms of the merit of the arbitral decision in favor of the passive tax subject and up to the end of the deadline provided for spontaneous execution of the decisions of the judicial tax courts, "restore the situation that would exist if the tax act subject to the arbitral decision had not been practiced, adopting the acts and operations necessary for that effect," which is in accord with what is provided in article 100º of the General Tax Law, applicable by force of what is provided in subparagraph a) of paragraph 1 of article 29º of the Legal Regime for Tax Arbitration[9].

Already pursuant to paragraph 5 of article 24º of the Legal Regime for Tax Arbitration in saying that "the payment of interest, independent of its nature, is due in accordance with the terms provided for in the General Tax Law and in the Tax Code of Procedure and Process" is nothing more than the recognition of the right to indemnificatory interest in the arbitral process.

Pursuant to article 43º of the General Tax Law, in the applicable part, "indemnificatory interest is due when it is determined, in a claim for reconsideration or judicial impugn, that there was error imputable to the services from which results payment of the tax debt in an amount greater than legally due".

In the case at hand, it is manifest that, following the declaration of illegality of the acts of assessment of IRS and compensatory interest, there is a basis for the payment of indemnificatory interest as the illegality of those acts is imputable to the Tax Administration, which, by its own initiative, practiced them without legal support.

There is a violation of substantive law, embodied in error on the assumptions of law, imputable to the Tax Administration.

Consequently, the Applicants have the right to indemnificatory interest, in accordance with article 43º, paragraph 1, of the General Tax Law and article 61º of the TCPC, calculated on the amount which was improperly paid, at the rate of legal interest provided for in article 559º of the Civil Code and currently in Ordinance no. 291/2003, of 8 April (articles 43º, paragraph 4, and 35º, paragraph 10, of the General Tax Law).

V. DECISION

Terms in which it is decided in this arbitral tribunal:

a) To judge the petition for arbitral determination to have merit;

b) To declare the illegality of the following acts:

– Assessment no. 2014 …, of 2014-02-15, with the amount payable of 2,090.14 € and assessment no. 2014 …, of 2014-02-15, with the amount payable of 49,897.27 €, both including compensatory interest;

– assessment of compensatory interest relating to the year 2009 in the amount of 269.20 € and relating to the year 2010 in the amount of 4,830.19 € (whose amounts were included in the tax amounts aforementioned);

c) To annul the IRS assessment referred to and declare null the assessment of compensatory interest;

d) To condemn the Tax and Customs Authority to pay the Applicant indemnificatory interest, in accordance with article 43º, paragraph 1, of the General Tax Law and article 61º of the TCPC, calculated on the amount which was improperly paid, at the rate of legal interest provided for in article 559º of the Civil Code and currently in Ordinance no. 291/2003, of 8 April (articles 43º, paragraph 4, and 35º, paragraph 10, of the General Tax Law), from the date on which the payment was effected until full payment.

VI. VALUE OF THE CASE

The value of the case is fixed at € 51,987.41, in accordance with article 97º-A, paragraph 1, a), of the Tax Code of Procedure and Process, applicable by force of subparagraphs a) and b) of paragraph 1 of article 29º of the Legal Regime for Tax Arbitration and paragraph 2 of article 3º of the Regulation of Costs in Tax Arbitration Proceedings.

VII. COSTS

The amount of the arbitration fee is fixed at € 2,142.00 in accordance with Table I of the Regulation of Costs of Tax Arbitration Proceedings, to be paid by the Tax and Customs Authority, since the petition was entirely successful, in accordance with articles 12º, paragraph 2, and 22º, paragraph 4, both of the Legal Regime for Tax Arbitration, and article 4º, paragraph 4, of the aforementioned Regulation.

Let it be notified.

Lisbon

18 March 2015

The Arbitrator

(Carla Castelo Trindade)

Text prepared by computer, in accordance with article 138º, paragraph 5 of the Civil Procedure Code (CPC), applicable by reference to article 29º, paragraph 1, subparagraph e) of the Legal Regime for Tax Arbitration.

The preparation of this decision is governed by the old orthography.

[1] Jorge Lopes de Sousa, Commentary to the Legal Regime for Tax Arbitration, in Guide to Tax Arbitration, Coord. Nuno Villa-Lobos and Mónica Brito Vieira, 2013, Almedina, page 202.

[2] ALVES PALMA, Ana Paula de Albuquerque, The Fiscal Transparency Regime - Analysis of the Effectiveness of the Regime in Portugal and Perspectives for Evolution, Master's Dissertation within the scope of the Master's in Accounting, Tax and Business Finance, Lisbon, ISEG, School of Economics & Management, September 2013, advised by Prof. Dr. Manuel Henrique Freitas Pereira, available on the Internet.

The nature of this regime is discussed within the scope of Corporate Income Tax: Non-subjection? Exemption? Merely instrumental subjection? For Saldanha Sanches and Casalta Nabais there would be a case of non-subjection to Corporate Income Tax as to the principal obligation (tax debt) and subjection to Corporate Income Tax as to ancillary obligations (cooperation duties). For Jorge Magalhães Correia it would be a case of exemption, as the legal requirement that the taxable matter of transparent entities be determined in accordance with the Corporate Income Tax Code would not be appropriate if a case of non-subjection were at issue. This is, however, a marginal question to the controversial question.

[3] In this regard, in one of the first Opinions produced by the Center for Tax Studies - Opinion no. 18/89, in CTF no. 354, APR-JUN 1989, pp. 275/286, and of which were Authors Maria de Lourdes Correia and Vale and Manuel Henrique de Freitas Pereira, having been sanctioned by dispatch of DG of 21-03-1989 - it was written that: "As a consequence of this regime - which always assumes, among us, a mandatory character - the societies and other entities to which the same applies are not taxed (article 12º of the same Code), but remain as passive tax subjects of Corporate Income Tax. This subjection is necessary as it is an essential instrument in the definition of the regime a). Indeed, the societies and other transparent entities are "unitary centers of reference" to calculate the values of base that should be imputed to their partners or members, calculation that is made observing the provisions of the Corporate Income Tax Code (nos. 1 and 2 of article 5º of the Code), including those that permit its correction (art. 78º of the Code)."

[4] COUTINHO DE ABREU, Jorge M., (Coord.), Code of Commercial Societies in Commentary, Vol. V, Almedina, Coimbra, pp. 290/298.

[5] Xavier de Basto: IRS: Real Incidence and Determination of Net Income, page 166-167.

[6] Cited work – Saldanha Sanches, Manual of Tax Law, 2005, p. 241.

[7] Rui Duarte Morais - On IRS, 2nd ed., Almedina, 2008, p. 214 and 215.

[8] Rui Duarte Morais – Notes on Corporate Income Tax, p. 37.

[9] Which establishes that "the Tax Administration is obliged, in case of full or partial merit of a claim, judicial impugn or appeal in favor of the passive tax subject, to the immediate and full restitution of the legality of the act or situation subject to the litigation, comprising the payment of indemnificatory interest, if applicable, from the end of the deadline for execution of the decision".